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Stock
Selection Guide Tutorial
Learning Stock Analysis |
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We have updated
the online tutorial originally
by Doug Gerlach that will help you understand SIG's analysis. |
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Partners |
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Note:
The following is used with the permission of the original
author.
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Section 2: Evaluating Management
The purpose of this section is to help the investor
to determine if the company's management is doing a good
job, by using two quantitative measurements: the %
Pre-Tax Profit on Sales (also known as the "pre-tax
profit margin" or PTP) and the % Earned on Invested
Capital (also known as the "return on equity" or
ROE).
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Entering the Data
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- A. % Pre-Tax Profit
on Sales
- To
calculate
the % Pre-Tax
Profit on
Sales, divide
the company's
Net Profit
Before Taxes
by that year's
Sales. %PTP
is expressed
as a percentage,
and usually
one decimal
point is
sufficient.
Calculate
the %PTP
for each
of the last
ten years.
Standard & Poor's
reports Pre-Tax
Profit in its
data sheets.
However, users
of Value Line
may may often
be thrown for a
loop because
this row uses pre-tax
profit for
the
calculation
instead
of profit
after
taxes.
The
rationale
is quite
simple,
though--taxes
are
entirely
determined
by outside
forces
and
it would
not
be fair
to blame
a company's
management
if the
powers
that
be in
Washington,
DC,
had again
increased
taxes.
Value
Line
reports "Net
Profit" after
taxes,
so additional
calculations
are
necessary.
Value
Line
also
reports
the company's
Tax Rate,
so you
can figure
the Pre-Tax
Profit
using
the following
formula:
Net Profit
______________ = Pre-Tax Profit
(1 - Tax Rate)
(Instead of dividing the Net Profit by the Tax Rate, you're dividing
by the Non-Taxed Rate, to give you the amount the company earned as profit
before it paid any taxes.) You can probably save a step on the calculator
if you can do the subtraction for the denominator of the equation in
your head. Think of the percentages as integers--100% minus 30.1% (if
the tax rate is 30.1%), results in 69.9%, and use 0.699 when you do the
division.
It
may be helpful to create
a third row in this section, "Row C",
to record the actual Pre-Tax Profit for each year that you calculate
in this way, as in the above example.
Now you can continue to divide the Pre-Tax Profit by the Sales in
the usual way.
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- B. % Earned on Invested
Capital
- Calculate
the ROE by
dividing
the Earnings
Per Share
by the Book
Value for
each of the
past ten
years. Again,
this figure
is expressed
as a percentage
and it is
usually adequate
to record
just one
decimal point
in the boxes.
A
side note:
You may find
discrepancies in the
book values
found in Standard & Poor's
and Value
Line.
This
is usually
because
S&P
excludes
intangibles
in its
calculation
of book
value,
reporting
Tangible
Book
Value
only.
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Calculating 5-Year Averages
- The next step is to calculate
the five-year averages for each
of these percentages. Add together
the last five years of the %PTP
and then divide by 5 to determine
the average % Pre-Tax Profit
on Sales of the last five years.
Do the same for the % Earned
on Invested Capital.
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Judging the Trends
- Finally, you need to determine
if any trends exist for both
ROE and PTP--has the percentage
gone up, down or remained flat?
If you have eliminated any
years as outliers in Section
1, you may also wish to remove
those years from consideration
in Section 2 as well. You may
also wish to give greater weight
to the most recent years, or
you can use the 5-year average
as a benchmark, comparing the
latest year to the average
to find a trend. Most investors
call the trend "even" if the
percentages only vary by just
a few tenths of a point from
year to year. In the above
example, a double-headed arrow
indicates an even trend in
the % Pre-Tax Profit on Sales.
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Interpreting the Results
- The pre-tax profit margin
tells you how much profit
the company makes on each
dollar of sales. The return
on equity determines how
much profit the company makes
compared to the total amount
of capital that has been
put into the business by
its investors.
In optimal conditions,
a company would be able
to consistently grow
its Pre-Tax Profit Margin
and Return on Equity.
A decreasing profit margin
or percentage earned
on equity may indicate
that a company is having
difficulties due to increased
competition, rising raw
material or labor costs
or other problems. If
the Return on Equity
is decreasing, the company
may not be using its
capital to best advantage
in generating profits
for its investors.
Both these figures vary widely
by industry, so in looking
at these percentages it is
helpful to compare the company
you're studying with others
in its industry. A company
with higher margins and return
on equity would generally be
preferred over a competitor
with lower percentages. A high
profit margin, on the other
hand, invites competition.
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*
This site not affiliated with the National Association of Investors
Corporation (“NAIC”) in any way, nor does NAIC
sponsor or endorse this web site or any of the products or
services offered herein.
The author founded a successful investment club and has been a member of NAIC
since 1990.
Stock
Investment Guide, SIG, Portfolio Analysis Review, Comparison
Analysis Review,
CAR, and PAR are trademarks of Churr Software.
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2015 Churr Software | A Taylor
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